10/01/2009 @ 5:40PM

Seeing the Light

William E. Macaulay isn’t opposed to green energy. Far from it: His Greenwich, Conn. private equity firm, First Reserve Corp., has investments in companies that sell pollution credits, design wind turbines, own and install solar systems, turn waste into diesel and syngas and turn barley into ethanol. But Macaulay is a reluctant convert. First Reserve XII, a $9 billion energy fund that closed in April, will put only 10% to 15% into renewable resources. “It’s expensive,” he says. “You need government subsidies–[which] come and go–and a lot of debt. That produces a lot of volatility.” Besides, Macaulay, 64, has made a fortune for himself and his investors in the business he knows and loves best: oil.

First Reserve is the largest private equity firm devoted exclusively to energy–mostly in extracting and marketing crude and providing oilfield services, along with some investments in coal and natural gas. Macaulay’s funds have generally been gushers, returning, net of fees, 10% to 50% a year, according to the California State Teachers Retirement System, a longtime investor. That’s an accomplishment during a period when the price of a barrel of oil has swung between $11 (December 1998) and $147 (July 2008). “Our long-term view of oil is $60 to $70,” says Macaulay. When oil roared past $80 in January 2008, he started selling several years’ worth of reserves on the forward market, a move that helped shore up First Reserve’s recent performance; in the first half of this year, revenue at his five oil and gas producers was up 45%, compared with an estimated 55% decline for the industry. Macaulay has made out well: His net worth is $1.1 billion.

Macaulay’s affair with energy was somewhat serendipitous. With degrees from the City College of New York and Wharton, he joined Oppenheimer & Co. “Everybody was supposed to cover something, so they decided some kid from the Bronx would cover energy.” Several promotions later he was running Oppenheimer’s mutual fund business, reporting to Leon Levy, the firm’s visionary cofounder.

In 1980 he launched a buyout firm with the intention of dabbling in just about anything. His fourth acquisition–a troubled investment manager, later renamed First Reserve, that lent to young and thirsty oil and gas outfits–changed his life. Spending only $1 for a 70% stake, he persuaded some of the firm’s investors to allow him to liquidate their portfolio for 13 cents on the dollar; the other funds he continued to manage. First Reserve launched its first buyout fund in 1992. Through Sept. 30, 2008, the most recent period for which data are available, it returned 25% annualized net of fees, according to Calsters.

Macaulay has no problem dealing with energy hot spots, like Libya and Kazakhstan, thanks to a Willie Sutton-like recognition: That’s where the oil is–an estimated 77% of the world’s reserves are in the hands of national petroleum companies. “The headlines will be, ‘Russia gets aggressive toward bp,’” he says. “But most of the time you’re working in Russia, you’re getting paid.”

Through its Abbot Group, First Reserve operates ten rigs on behalf of Russian companies and partnerships in western and eastern Siberia. The firm’s interests in deepwater exploration have led it, via Cobalt International Energy, to sign offshore leasing agreements in Angola near the enclave of Cabinda, the scene of a simmering conflict between the government and dissidents, and Gabon, a squalid little dictatorship controlled for four decades by the Bongo family.

First Reserve is not squeamish about the Venezuelan government. Last spring, when Shell was looking for a place to stash its oil in the Caribbean, a giant storage terminal on Grand Bahama Island beckoned. Most of it was being used by its owner, the state-controlled Petróleos de Venezuela, and Shell didn’t want to become a landlord. So Macaulay stepped in, offering a reported $900 million, then brought in terminal operator Vopak to run it. Shell agreed to lease 40% to 45% of the terminal; the Venezuelans and a handful of smaller tenants occupy the rest. The place should generate Ebitda of $96 million.

Alternative energy is a lovable sector, but the economics are dismal. The
U.S. Energy
Information Administration estimates that a kilowatt-hour of electricity from a photovoltaic solar plant entering service in 2016 will cost 40 cents (in today’s dollars). That’s three to five times the projected cost of electricity generated from natural gas, coal or uranium. Wind power, by this measure, costs 12 cents. Subsidies, enhanced in the new stimulus program to cover 30% of the capital costs of renewable energy projects, have nudged wind significantly closer to grid parity but still leave solar far behind.

Even with a government lift, says Macaulay, “It’s a lot more expensive to put transmission lines in to gather power from 100 different wind farms, scattered around in farm country, than it is to hook up one nuclear plant.”

Still, Macaulay can’t be too dismissive of renewable energy because it will soak up a lot of money–especially in building infrastructure. Solution: invest in suppliers of equipment. Last year First Reserve agreed to invest as much as $300 million in Kenersys, a young outfit owned jointly with Indian metal casting billionaire Baba Kalyani. Staffed by former GE engineers, Kenersys makes a turbine capable of powering itself when the grid it is attached to has failed. Scandinavia, known for its bracing winds, is an obvious customer; so are India and Inner Mongolia.

First Reserve has a hand in solar panels and installations via 9Ren Group of Rome and Madrid. The European Union has resolved to derive 20% of its energy from renewables by 2020. While utilities in Spain and Germany have gone for (subsidized) solar in a big way, other countries–notably Greece, Italy, Portugal and France–are playing catch-up. With subsidy spigots already open, 9Ren should do well.

But enough about renewable fuel fantasies. “The world still runs primarily on oil, as well as natural gas and coal,” Macaulay says. “Fortunes have been made in oil and gas and will continue to be made there.” He seems most excited about deepwater prospects in the gulfs of Mexico and Guinea. The crude here lies trapped at the bottom of the ocean in fields capped by dense mineral layers that scatter seismographic waves, making them difficult to map and measure. Recent advances in drilling technology have unlocked vast subsalt reservoirs, like the 5 billion to 8 billion barrels of oil and equivalents in Brazil’s Tupi. Only a handful of the world’s exploration companies have the skill to start drill pipes under 2 miles of water. One of the smaller ones is Cobalt. Macaulay’s funds own an undisclosed minority of this firm that expects its first revenue in 2012; Cobalt hopes to go public soon.

First Reserve isn’t in Brazil just yet. But it has the wherewithal to go almost anywhere. Out of $19 billion under management, the firm has $8.5 billion or so in cash waiting for a home.